Notes on the Week Ahead

To be good long term investor, you need courage and you need brains.  However, you need them in different quantities at different times.  In the depths of a bear market, you mostly need courage since it’s almost a “no-brainer” that the economy will recover and will lift financial assets with it.  In a bull market, its mostly about brains since, while people are less haunted by economic fears, valuations are higher, increasing the need to be more discriminating in both asset allocation and security selection.

As the calendar flips to August this week, consumers, workers, investors and the Federal Reserve all have reason to be pleased with recent data. Stock market returns have been strong all year, economic growth has been surprisingly resilient, unemployment remains very low and, despite all of this, inflation has fallen sharply. The Fed continues to tighten in a manner that appears aggressive given the balance of risks. However, so far, this does not appear to have inflicted too much damage on the overall economy or markets. So where do we go from here? One approach to this question is just to review an economic checklist of Growth, Jobs, Inflation, Profits and Rates.

The pandemic was my excuse to abandon piano lessons.  It wasn’t that I wouldn’t practice or didn’t enjoy pounding away on the keyboard.  The problem was that my piano teacher, Tatiana, is a perfectionist.  She wanted me to get it exactly and precisely right and so I practiced the same piece over and over.  She would smile as I did my lessons but it was a strained and pathetic smile, as the masterpieces that she had loved from her youth were mangled, tortured and slowly murdered in a most grizzly fashion by yours truly.  Finally, I couldn’t do it to her anymore and I used the pandemic as a way out.

Over the centuries, an abiding tension among many major religions has been the pendulum of severity. One era will be marked by a relaxed view, where smiling clergy make liberal allowances for minor transgressions. However, this is often followed by a puritanical reaction, wherein the flock is warned that the path to salvation is an exceedingly narrow and rocky one. The Federal Reserve seems to have undergone a similar transformation in recent years. Long gone are the days of “average inflation targeting” and praise for the beneficial effects of a super-tight labor market. Inflation is now the eternal and infernal enemy and the Fed will yield no quarter in battling it.

When I first arrived in this country, 40 years ago this summer, my strongest impression was that America was a land of optimists. European economists, politicians, commentators and consumers all saw the outlook as dark and troubled. However, Americans, facing equal challenges, seemed to see the glass as half full.

I have a sad tale to relate.  After dodging Covid for the last three years, my wife Sari and I were at a wedding two weeks ago and the virus decided to crash the party.  Two days later, I tested positive and Sari tested negative.  I’ll spare you the grim details, since almost everyone has had a similar experience.  However, despite only mild and fleeting symptoms, I experienced a rebound and so I’m sitting alone, testing daily, and waiting for a negative so I can return to society. Investors in 2023 have also been waiting for a negative.  Waiting to see if economic growth would turn negative.  Waiting for a well-established negative trend on inflation.  And waiting for the Federal Reserve to perceive enough general negativity to stop raising interest rates.  As the first half of the year draws to a close, the wait continues.  However, in rather sharp contrast to my predicament, there is plenty that investors can do while they wait.

One of the advantages of being back in the office, when I am actually in the office, is I get to hear a variety of opinions.  These opinions are sharply divided today on the issue of a U.S. recession.  One camp feels that recession is inevitable.  Another sees a path to a “soft-landing”.  Of course, this argument really refers to a recession starting in the next quarter or two.  Sooner or later, a recession will occur. However, that brings up other questions, namely, when will a recession start, how deep will it be and how long will it last? 

Markets in the week ahead will be focused on Wednesday’s FOMC meeting. We expect the Fed to leave the federal funds rate unchanged although both the post-meeting statement and the dot plot will likely emphasize that inaction this week should be considered “skipping a rate hike” rather than putting an end to monetary tightening. Indeed, Fed communications could explicitly warn of a possible further rate hike in July. On balance, however, cooling data on inflation and growth between now and that meeting should be enough to convince the Fed that no further tightening is warranted. Some of these data will be released this week.

In 1787, on the last day of the Constitutional Convention, a lady asked Benjamin Franklin what form of government had been agreed to.  He famously replied, “A Republic – if you can keep it”.  He was, of course, alluding to the danger that partisanship or ill-advised policies could yet return the young country to the monarchy it had so recently escaped. 

I am shockingly, comically bad at golf.  However, that doesn’t stop me from occasionally watching more gifted souls play the game.  One of their techniques is to examine a putt from multiple perspectives.  They take a careful look at the green as they come up to mark their ball, look at the putt from the side, squat down to consider it from the opposite direction, and generally scout out the lay of the land from all angles.  For myself, since I’m generally wielding the putter playing my seventh or eighth, I don’t further test the patience of my companions with such preparations.  However, I will admit that, for the average golfer, looking at a putt from multiple angles yields useful information. A similar rationale can be applied to monetary policy decisions.  Changes in monetary policy are among the most important drivers of stock and bond returns.  Consequently, one of the questions we are asked most frequently is where will the federal funds rate be at the end of the year?